Good morning, ladies and gentlemen. My name is Terry and I will be your conference operator today. At this time, I would like to welcome everybody to the Donegal Group, Inc. Q3 2018 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]. Please note that today’s call is being recorded. Thank you. I would now like to turn the call over to your host for today Mr. Jeff Miller. You may begin your conference.

Thank you very much. Good morning, everyone, and welcome to the Donegal Group conference call for the third quarter ended September 30, 2018. Yesterday afternoon, we issued a news release outlining our quarterly results. For a copy of that release, please visit the Investor Relations section of our website at donegalgroup.com. In today’s call, Kevin Burke, President and Chief Executive Officer, will discuss a number of our recent developments and update you on our business strategy and initiatives. And I'll follow his comments with a brief overview of our quarterly financial details. Following our prepared comments, we will open the line for any questions you may have. Before we get started, you should be aware that our commentary today includes forward-looking statements that involve a number of risks and uncertainties. We describe forward-looking statements in our news release and we provide further information about risk factors that could cause actual results to differ materially from those we project in the forward-looking statements in the report on Form 10-K that we submitted to the SEC. You can you can access our Form 10-K through the Investors section of our website under the SEC filings link. We also use certain non-GAAP financial measures to analyze our business results and refer you to the reconciliation of non-GAAP information included in the news release we issued yesterday. With that, I'll turn it over to Kevin.

Thanks, Jeff. And welcome, everyone. In the third quarter, we continued to make progress on key initiatives to improve our underwriting performance and operating efficiency. Over the course of 2018, we've been working diligently to manage the mix of our new business writings, to build upon our commercially-focused agency relationships and to get Donegal back on track to achieve our core objectives, which are consistent underwriting profitability, enhanced financial stability and book value appreciation for the benefit of all of our stockholders. Let me begin with an assessment of our underwriting performance. We continue to shift our mix of business to include a greater percentage of commercial insurance, and we are pleased to report higher net premiums earned and a continuation of net premiums written growth in our commercial business segment. Our commercial growth was largely due to a combination of rate increases and new business writings. In the first half of the year, we spoke at length regarding the challenges within the commercial auto line of Donegal and across the entire property and casualty space. We've taken proactive measures to address the loss severity increases. Those measures include comprehensive re-underwriting of the commercial automobile policy renewals in several underperforming state as well as definitive underwriting and pricing actions, primarily based on predictive model scoring of each renewal policy. We are obtaining high single and, in some cases, double-digit renewal premium increases throughout our commercial auto line, depending on the individual loss experience of a given account. We've implemented and will continue to implement commercial automobile rate increases in all the states in which we are actively writing business. Our workers’ compensation line has performed well over the past two years. However, there is considerable competition in this space and we are choosing to exercise pricing discipline, even if that…

Thanks, Kevin. I’ll briefly discuss a few of the operational and financial metrics for the third quarter. Beginning with premiums, our net premiums written increased 1.1% to $184.5 million for the third quarter 2018. The increase includes 6.8% growth in commercial lines, offset by a 3% decline in total personal lines. Starting with commercial lines, commercial auto was a line in which we achieved the largest percentage growth, which was primarily due to average rate increases in the high single-digit percentage range and even double-digits in several states where that line of business has underperformed. As Kevin mentioned, we’re continuing to see increased competition in the workers’ compensation line throughout multiple geographies, which explains the relatively slower growth rate in that line of business. The increase in other commercial lines net premiums written reflects a modification to third-party reinsurance coverage related to umbrella liability policies that was effective March 1, 2018, pursuant to which we’re retaining a higher proportion of this historically profitable business. Moving to personal lines, we've continued to implement rate increases and adhere to tighter underwriting guidelines in both personal auto and homeowners. As a result, we have successfully slowed the rate of new business growth and experienced some policy attrition by design in certain geographical areas. We are relying heavily on the risk index scores our predictive model provides and taking actions to the extent permitted by regulatory authorities to improve the pricing efficiency and profile of our personal lines book of business. Net premiums earned increased 5.9% compared to the third quarter 2017 to $187.7 million. We expect our premium growth will continue to reflect a proportionately higher impact of rate increases versus exposure growth in the fourth quarter and into 2019. Moving to underwriting performance, our loss ratio in the third quarter was 75%…

Thanks, Jeff. We’ll open the lines for questions in a moment, but I want to provide a brief update on our pending sale of Donegal Financial Services Corporation and Union Community Bank to Northwest Bancshares. We are pleased that the process remains on track to close on this transaction in the first quarter of 2019. We and Donegal Mutual intend to utilize the proceeds from this sale to support our strategic goals as we focus on our core property and casualty insurance business. With that, we’ll ask the operator to open the lines for any questions that you may have. Thank you.

[Operator Instructions]. And we do have one question from Christopher Campbell.

Yes. Hi. Good morning, gentlemen.

Good morning, Chris.

Good morning, Chris.

Hey. I guess the first question is on the average reserve development, which I thought was very helpful, just the extra color you provided on the Peninsula claims pieces. But are there any other movers that you guys had in the quarter underlying that?

Sure. This is Jeff. As you mentioned, the Peninsula claims, that would've accounted for the commercial auto development and that was fairly modest at about $1.2 million. The majority of the unfavorable loss development, that was in private passenger auto. And there, it was about $3.8 million. And as I mentioned in my prepared comments, there's a few things that were at play in that development. There was some additional analysis of the reporting trends that we talked in our first quarter call, and that was coupled with some case reserving methodology changes that we put in place also as a result of the reporting trends that we identified in the first quarter. So, the case reserving methodology changes resulted in some prior-year reserve increases and the actuaries, as they did their analysis, did not fully offset these case reserve increases with IBNR decreases. So, the net effect of that was just further strengthen reserves in that particular line of business. But I would like to make it clear that we didn't identify any additional or new trends that drove that activity. It really was a continuing response to what we've seen in the first half of the year.

Okay, got it. So, just to make sure I understand, it’s like you had – all right, you had $5 million unfavorable or like if I'm adding the $1.2 million from commercial auto and the $3.8 million or do those offset [indiscernible] $2.6 million?

Yeah. You're correct. We had $5 million in the two auto lines and then that was offset by favorable development in workers’ compensation in the amount of about $2.7 million and then there was net favorable development in other lines that would've made up the difference.

Okay, got it. That's very helpful, I guess. And then, next question on the Safeco deal. So, why those states in particular? Was there anything just in terms of distribution, fit within your footprint? So, I guess, how did you pick those states? And also, like, if I'm looking at commercial auto, that seems kind of just as poorly performing as personal auto. So, could you do something similar to the personal auto deal for commercial?

Chris, this is Kevin. First off, on the seven states that were identified, one of the things that we've quickly looked at is, obviously, the loss ratios in those seven states and the performance of that personal lines book per state. Secondly, as we looked at rate indications in terms of what we would need to be doing over the next two, three, five years in terms of being able to file rates, get them approved and find out whether or not we think that we could get a point of rate adequacy and there was a length of time there that that we looked at and we didn't think that that it was reasonable. Thirdly, we looked at also market share. When we looked at each of those states, particularly the New England states, we have very, very small books of business there. So, in addition to having to take aggressive rate, we also looked at how would we achieve the appropriate scale that we would need and spread of risk and personal lines. Those three items in particular sort of made us sit back and identify those particular seven states. And as I had noted, I think it's very much going to accelerate our ability to sort of get back to a level set for personal lines. In terms of commercial lines, that’s a different animal. The commercial lines auto book, you're right, the performance is not there. But you have to also remember that that is very much part of a package policy when we sell the commercial business. Auto is typically part of that. And the other aspect of it is commercial auto is a much smaller percentage of our overall total book of business, in the 13%, 14% of our total book of business as opposed to private passenger auto, which is 30%. So, our ability to sort of manage the smaller commercial auto book, get rate adequacy and ensure that we’re not disrupting that commercial book of business, particularly as it relates to the package policies is very important. Auto, we saw this really as an opportunity to accelerate the recovery of our person lines, and that's how we really got to those seven states.

Okay. That's helpful. And is there any negative impacts from pulling back in personal lines in those states on the commercial lines? Are you going to alienate any agents in those states on the commercial side?

We were very, very sensitive about that particular topic before we decided to move forward with this book transfer. We had roughly about $13.5 million dollars of commercial business that was represented in those seven states. And since we made the announcement, Chris, I have been out in the various regions talking to agents, and we have gotten very, very little pushback. If anything, they've been very supportive of it because they're understanding that, as an agent with Donegal, they're also looking at their profitability with our company. And so, if they had a small commercial or a small personal lines book of business that was not performing, the fact that we have really provided them an opportunity to transfer their book of business and not just simply exit the state – some carriers will do that. They will take a very aggressive approach and simply exit a state and you leave the agent left with now having to place that business. We've taken the approach where we have provided really a resource for them and they viewed it as a very positive way of exiting those specific states.

And, I guess, just switching to workers’ comp, results are still good. Now, I've heard from some competitors that there is pressure more on like new business commissions, there is – some competitors are being aggressive in terms of paying, like, contingents on new business, maybe up to 500 bps higher than the base commissions. I guess, what are you kind of seeing in your policies on the workers’ comp side?

Chris, we are seeing that in the market. And, in fact, we did increase commission rates workers’ comp in 2018. So, we have responded to some of those market pressures by increasing the compensation we pay to the agents. We've seen some intense competition from monoline workers’ comp writers that are being aggressive in the marketplace. And through the first half of the year, you had seen our premiums actually had declined in workers’ comp. And in the third quarter, we've kind of stabilized that. Although it wasn't a significant increase, we did have a 1.1% increase in our net premiums written. So, we’re fighting for the business and doing everything we can to retain the quality accounts because, as you know, that's been a very solidly performing line. The other thing that’s putting pressure on that line of business is that a lot of the states are putting rate decreases through, and so we’re having to respond to that as well. So, it is a line that's under pressure and we are committed to continuing to fight for the quality accounts.

Got it. And you had mentioned the monolines being competitive. Are you also seeing, like, kind of the larger national carriers being competitive as well?

Yes. It’s a line that’s very attractive because of the very good loss ratio performance over the last five years.

Yeah. Okay, got it. And then, just kind of one more on the shares. So, you guys are down, like, I don't know, like, 22%, 23% on the year. You guys are below book value right now and you're going to get the proceeds from the bank sale. So, is there an opportunity to kind of buy back shares? Does that get attractive now that you guys are below book? I guess, how would you think about that? I know there is like the adverse piece to, like, the liquidity, but it seems like this would be a kind of an attractive purchase right now?

Well, certainly, any time your stock is trading below book, it causes you to look at that. We have not had any real serious discussions about doing that at this point. We certainly will take a look at it when we have the proceeds in hand. But at this point, our plans are to invest those proceeds into the property-casualty operations. From Donegal Mutual standpoint, there’s significant investment being placed into the technology, and so that would be a use of the proceeds there on the Mutual side. And then, on Donegal Group side, as we have increased our premium growth in some of our subsidiaries and, frankly, because of our less-than-targeted underwriting performance, our surplus growth has not kept pace. So, our plan would be to put some of those proceeds into the surplus of our subsidiaries to support future growth, and that's really our focus at this point. But we will definitely take a look at the situation in the first quarter when we have those funds in hand.

Got it. And just one kind of final one on the Mountain States piece. It sounds like Kevin had said that that might come into the pool in 2020. So, I guess, how good does that book have to perform before you let it into the pool? Is there like a specific combined ratio target? I'm trying to think, like, just modeling that out?

Sure. There's not a specific combined ratio that we’re looking at before we bring it in. What we’re looking at, Chris, is all the indications right now are that we have a very, very solid foundation that we’re operating from. We are starting to see new business growth. We have about $3.5 million to $4 million of new business growth that's coming in. The loss ratio on the existing book of business is very, very low, so we see it as a very healthy position to be in. And the overall premium rate increases that we’re seeing on the entire book as we sit here today is 9%, which is very good. We have an 87% retention on the remaining book of business. This was after we did all the re-underwriting. And so, we feel as though, for 2019, as we go into the year, what we’re looking for Mountain States to do is really sort of grow into their expense ratio, but the underlying book of business, as it stands today, is performing very well. And I think, for 2020, our expectation is that that will continue and we’ll be able to bring that into the group, which would be, obviously, our long-term goal.

Okay. Well, thanks for all the answers. Best of luck for the rest of the year.

Thanks, Chris.

Thank you, Chris.

Okay. You have another question from Bob Farnam.

Yes. Hi there. Yeah, Chris covered most of the hot topics there. So, I guess, the one question I have was the rate increases in the commercial lines book, how are they relative to loss trends? Just trying to get a feel for kind of the underlying underwriting profitability going forward.

Sure. We basically already covered the workers’ comp where the premium growth there is pretty much flat. In commercial auto, we are seeing some significant increases. As you look at the overall growth rate, it is all rate increase. We currently do have some new business growth, but that being offset by attrition, some of which is by design. Much of it is by design. So, the growth that we’re seeing in that line is rate increase. So, your question is how does that relate to the loss cost increases. And that remains to be seen because, as you know, we've seen a significant increase in loss costs, and particularly we have adjusted what we thought our lost costs were going to look like a year or two ago. So, as we’re rolling all of those changes in our expectations through our rate indications, we believe we’re catching up. But I don't think we can sit here today and say that it’s a finished work. It is still very much work-in-progress. The re-underwriting continues and it's being done on every account that is in certain states or that is scored in the higher deciles through our predictive model. All of those accounts are getting a significant amount of scrutiny and we are walking away from business that has underperformed or that we believe will underperform in the future. So, that’s very much a work in progress. On the commercial multi-peril line of business, the rate increases there are more modest. They're in the lower single-digits on average in the third quarter. We saw 2.6% rate increase on the premiums in that particular line of business and we grew in a 5.5% rate. I'm looking at direct premiums which are a little bit different from the net premiums that we would've reported in the release yesterday. So, that gives you kind of a flavor for the real aggressive rate activities in the commercial auto. We believe we’re catching up to the loss costs there. In commercial multi-peril and workers’ comp, we believe we’re keeping pace.

All right. Great. Thanks for that, Jeff. So, it basically sounds like the commercial auto is still working on it basically. Like you said, it's a tough line to get back on track with. Okay, that’s it for me.

All right. Thanks, Bob.

Thanks, Bob.

And there are no more questions at this time.

Okay. We want to thank everyone for participating in the call today. And thank you, Chris and Bob, for the good questions. We look forward to speaking with you again after the close of the year.

Thank you.

Ladies and gentlemen, this concludes today's conference. You all may now disconnect.